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Three Great Bond ETFs Investors Have Overlooked

Despite concerns over low yields and a brewing bond bubble, many investors have plunged into fixed income ETFs. In fact, even with the broad market concerns, over $43 billion in new capital has gone into the broad bond ETF space since the start of 2012.

Most of this fresh cash has gone into a few choice products, mostly in either the high yield market, broad fixed income world, or the investment grade space. For example, over $11.66 billion has gone into two products alone so far this year; HYG and LQD.

This suggests that investors are highly concentrating their bond exposure into the most popular and well-known names in the fixed income world, forgoing exposure to a number of more specialized ETFs in this segment. This could be to investors’ detriment, as 2012 has been a year of innovation in the fixed income world giving investors access to a variety of new segments and more targeted exposure (read ETFs That Will Haunt Your Portfolio).

While a number of these new funds have expanded the global bond exposure lineup, there are still a number that are segmenting the American bond market in new and interesting ways.

Given this, some investors who are big on bonds this year may want to look beyond the ultra-popular funds and instead take a closer inspection at some of the oft-forgotten funds in the bond world that can potentially provide better—or at least more targeted—exposure to the fixed income world (See Go Local With Emerging Market Bond ETFs).

For these bond investors, we have highlighted three of our favorite new U.S.-focused bond ETFs below which have seen little in inflows despite their potentially superior methodologies, or more impressive segmenting abilities.

Either way, any of the following three funds could be worth a closer look by investors seeking more fixed income exposure, but are searching for more choices beyond the top tier of funds that seems to get all the attention—and inflows—in today’s uncertain market environment:

This ETF, which debuted in April 2012, tracks the BofA Merrill Lynch US Fallen Angel High Yield index, which is a benchmark of U.S. issued bonds that were rated investment grade at issuance but are now junk. This produces a fund that has just under 70 bonds in its portfolio with the vast majority rated at the ‘BB’ level.

Van Eck believes that this technique of focusing on the ‘fallen angels’ could outperform traditional high yield techniques as these firms tend to have better debt profiles and more financing flexibility than their peers. Additionally, these bonds have performed better with similar risk as other high yield bonds, according to their research.

Additionally, the fund could be a nice yield destination as well, as the ETF has a 30-Day SEC yield of 5.7%, while charging a relatively low 40 basis points in fees. Still, the product has little in AUM or volume, suggesting somewhat wide bid ask spreads for those seeking to actively trade this intriguing, but often overlooked bond ETF (see the Truth About Low Volume ETFs).

For investors seeking high yields but more safety, XOVR could be an interesting pick as the fund tracks the BofA Merrill Lynch US Diversified Crossover Corporate Index. This benchmark focuses on securities that have an average rating of BBB1 to BB3, thus targeting the high quality end of the junk market, and the low quality end of the investment grade space.

State Street’s research suggests that this space may have less credit risk than most high yield securities but with higher yields than investment grade bonds, potentially making it a ‘sweet spot’ for investors in the bond market. In some ways, this product looks to include both the fallen angels of ANGL as well as junk securities that are slowing trying to rise into the investment grade category (read State Street Debuts Two Bond ETFs).

With this approach, the ETF has a 30-Day SEC Yield of 3.5% while charging investors an ultra-low 30 basis points a year in fees. Like others on the list, the fund hasn’t seen huge inflows since its inception (June, 2012), as just $13 million is under management, suggesting wider bid ask spreads once again.

The last fund on this list has seen a little bit more interest than the others, possibly due to the unique focus of CMBS. The product targets the Barclays US CMBS (ERISA Only) Index, giving the ETF exposure to the broad commercial mortgage-backed security space.

Even with the declining rates and possible Fed intervention into the broad MBS market, the yield on CMBS is quite good, coming in at 4.3% in 30 Day SEC terms. Investors should also note that the fund is a low cost choice at 25 basis points a year in fees, while volume and AUM are likely to produce modest spreads for this fund, particularly when compared with other products on this list.